Gifting for purpose of Support Test (AOTC)

Taxpayer has a 20 year old child who is a student. Child earns about $5,000 in wages which are used to pay rent at school, etc. Parents are paying tuition for the child, which effectively means they are paying more than 50% of support and thus the child is not able to claim themselves as a dependent.

Parents AGI exceeds the eligibility range for Education credits.

But if the child is gifted the funds into their personal bank account, and tuition is then paid by the student out of that account, and assuming those tuition payments, plus rent paid from their earned income exceeds 50% of their support, would the child then be able to claim themselves on their returns and thus qualify for the refundable AOTC?

Obviously we're now talking $1000 refundable AOTC on the kids return vs $500 Other Dependent Credit on the parents' return.

But can gifted funds be used for the student to pass the (self) support test?

Seems too convenient, but might be good tax strategy?... well for 500 bucks at least... it's something.

Not eligible for refundable credit because kid does not pay over 1/2 support with earned income. Weird overlap of kiddie tax rule and refundable AOC credit rules.

If kid has taxable income then parent can not claim kid, kid cannot claim kid (which does not really matter much anymore) and kid can use AOC to reduce tax liability (but not refundable).

Recently found out that under the above scenario, parents can still claim kid as dependent for California purposes.

Clarify EZ, "If kid has taxable income"

What exactly did you mean by that?

Not eligible for refundable credit because kid does not pay over 1/2 support with earned income.

Do you have a cite for this? This was my original analysis, but something I read led me to believe this was only the Kiddie tax rules, and there is no earned income requirement for the AOTC, but I've been unable to confirm nor deny.

If earned income is required I have a bit of an issue with a student who had some income come from a fellowship grant he worked on during the summer. The letter from the university says "no deductions are made for any purposes, such as income tax, or social security. As a result, W-2 Forms will not be sent to you. You must maintain your own income tax records..."

They did not receive a 1099 either, but it's my understanding this should be reported as other income on their 1040, not subject to SE.

But if this income is not subject to SE, I presume it would not be considered earned income, even though they worked to earn the money. Although they provided more than half their own support, if they lack sufficient earned income (they had $10K of grant income, and $2K of other W-2 income) you're telling me they wouldn't qualify for AOTC, right?

Okay, I still can't find a direct cite, but I've read from multiple sources that 1/2 their support must be from earned income, so I'm satisfied EZ is correct.

And I think my client in this situation only has $2,000 of earned income (disregarding the grant income). So I think we're SOL on refundable AOTC.

Your worst case scenario would be if you had this situation and the parents would qualify for the full credit (below $160K AGI) but didn't provide half the student's support so couldn't claim it. And the student with unearned grant income lacks sufficient earned income to take the credit. This could happen to fairly low income taxpayers who I would think the IRS is trying to assist with education expense.

That just seems unfair, and makes me wonder if I'm misunderstanding the law...

This is why I have parents in high income tax brackets (who have businesses) put kids on salary and then have the kids pay the tuition. The numbers don't always work out, but usually do. FWIW.

Just as long as the child is being compensated for work performed...

Absolutely.

Per Pub 970 pg. 21

https://www.irs.gov/pub/irs-pdf/p970.pdf

Refundable Part of Credit
Forty percent of the American opportunity credit is refundable for most taxpayers. However, if you were under age
24 at the end of 2018 and the conditions listed below apply to you, you can't claim any part of the American opportunity credit as a refundable credit on your tax return.
Instead, your allowed credit (figured on Form 8863, Part II)
will be used to reduce your tax as a nonrefundable credit
only.
You don't qualify for a refund if items 1 (a, b, or c), 2,
and 3 below apply to you.
1. You were:
a. Under age 18 at the end of 2018, or
b. Age 18 at the end of 2018 and your earned income (defined below) was less than one-half of
your support (defined below), or
c. Over age 18 and under age 24 at the end of 2018
and a full-time student (defined below) and your
earned income (defined below) was less than
one-half of your support (defined below).
2. At least one of your parents was alive at the end of
2018.
3. You are filing a return as single, head of household,
qualifying widow(er), or married filing separately for
2018.